Ev Ehrlich's Everyday Economics

The Fed Under Seige

The ongoing saga of the recovery that wasn’t took a new turn this week when a group conservative politicians and economists – some of them often rational, at least in my book -- launched a coordinated assault on the Federal Reserve and its (Republican) Chairman, Ben Bernanke, for displaying the audacity to act in line with the Fed’s oft-repeated and uncontroversial mandate to provide full employment with price stability – the quantitative easing (QE2) program.

Faced with a situation in which inflation was less than the Fed’s (again) oft-repeated and uncontroversial target of 2 percent inflation, and with unemployment significantly less than the “non-accelerating inflation rate of unemployment,” as we economists have decided to call “all the employment the economy can handle,” the Fed has announced its intention to do what you would do if you read its owners’ manual – lower interest rates by printing money and using it to buy bonds, meaning more money gets into circulation and, hopefully, it sticks somewhere.  But since short-term interest rates are already pretty low, the Fed announced that this time it would march further out the “yield curve,” meaning it would be buying bonds of 5 or 10 years duration, to establish that money was not only going to be cheap, but be cheap for a while.

The best argument for the soundness of this policy may be the voices against it.  Liberal icons Joe Stiglitz and Paul Krugman have both questioned the policy on the grounds that more fiscal stimulus is needed instead.  That’s swell, guys, but since more fiscal stimulus isn’t forthcoming, what’s Plan B?  Apparently, it’s whining about how we didn’t do Plan A.  Gene McCarthy  once said that “the function of liberal Republicans is to shoot the wounded after battle.”  That appears to be Joe’s and Krugman’s function as well.

But the real stars of the show are a group of conservative economists, like my friend – really -- Doug Holtz-Eakin, the well-regarded and very droll senior economic advisor to the McCain campaign, and right-wing fellow travelers like Weekly Standard’s William Kristol or my good friend (and, again, I’m not kidding) and crackpot Amity Schlaes, who recently devoted an entire book to the remarkable? whacky? idea that Roosevelt’s Depression-Era policies were a big mistake that only hurt working people (here’s the link, which opens with a George Will quote about reappraising the New Deal, which is like asking the Mongoose for a review of a book reappraising the Road Runner). 

This new group has run an ad in the Wall Street Journal (from whence it will trickle down to the masses)   in the form of an open letter to Bernanke.  The letter says his plan will “…risk currency debasement and inflation, and we do not think …(will promote)… employment.”  Instead, perhaps like Stiglitz and Krugman, they offer “…improvements in tax, spending and regulatory policies must take precedence in a national growth program, not further monetary stimulus.”  But what they mean here is permanent extension of the Bush tax cuts, including cuts for the top of the income ziggurat, maintaining the distinction between wages and salaries on the one hand and (less-taxed) capital gains on the other, and better treatment for the rich dead through elimination of the estate tax, coupled with unspecified spending cuts and deregulation, which I suspect means repealing the new health care law.

How this will lead to sustained growth in employment is beyond me.  After all, the tax cuts have already happened – what they mean by improving tax policy is not raising taxes on the rich.  And spending cuts (as part of a deficit-reduction plan) are going to be sorely needed once the economy starts growing, but cutting spending in order to induce growth is like dowsing a campfire before dinner’s cooked in the name of forest safety.

And how this is going to lead to inflation is also hard to imagine.  Capacity is ample and the economy has plenty of slack.  Hundreds of millions of people around the world are entering the tradable economy and are prepared to send us an ever-increasing slate of products for next-to-nothing.  Astonishing technological progress is fueling productivity growth.  See anybody striking for higher wages recently?  Me, either.

Let me reiterate what I discussed last week; the Fed’s policy is the best option we have right now.  Like Joe and Krugman, I’d rather a new round of stimulus, but since that’s not going to happen, I’m for Plan B.  Specifically, I think the missing element of economic policy right now is a drive to refinance the stock of mortgage debt, which would give people lower payments and therefore more income, keep foreclosures down and therefore keep more houses off the market, firm up the price of housing a bit, and give consumers a reason to get up in the morning.  Too bad the Congress won’t do that – actually, too bad the Administration won’t do that – but the Fed can take us close to it by making 5-10 year money so cheap that it does.

The dissent of the conservative economists has the veneer of a polite debate over monetary policy.  There’s always been such a debate.  Back in the 1970s, when the Fed, under Nixon, Ford, and Carter, under such lesser lights as Arthur Burns and William Miller, either turned a blind eye to or tacitly encouraged rising inflation, a similar group of conservative economists formed what they called the Shadow Open Market Committee, which advocated a tougher line on monetary expansion.  In essence, they won the argument, since Paul Volcker became Fed Chairman soon thereafter and implemented the austerity the Shadows had long supported in order to squeeze inflation out of the system.  (The Shadows, however, proceeded to fight the war after they’d already won it, and continued to complain about unduly lax monetary policy even after the economy began to grow again, even though inflation had disappeared, thus rendering them a bit less prescient than you would have thought.)

The Shadow Committee was openly and avowedly for austerity, and anti-growth.  That’s not unfair in the least – their view was that if it took a recession to squeeze inflation out of the system, then so be it.  And Volcker had the guts to do it.  At the time, I was horrified – horrified – that we’d choose to have 10 percent unemployment.  Now, liberals like me see Volcker as the only guy who gets what’s going on in financial markets and, by the way, he did get rid of inflation.  So much for our objections.

But here’s the problem.  The new group of anti-Fed conservatives appears to be just as anti-growth as their Shadow predecessors, just less honest about it.  The vague discussion of tax, spending, and regulatory policies is the same melange of stuff that Congressional Republicans now favor but are yet to spell out.  Is extending tax cuts for people with incomes over $250,000 (or now, as Senator Schumer appeared to suggest over the weekend, incomes over $1 million, graciously taking me out of the mix) and repealing health care (actually, to my thinking, insurance regulatory) reform going to trigger a new round of growth and employment?  Or what – letting GM go broke?  Can I have some of what you’re smoking?

Or perhaps what’s really going on is that this new group of dissenting economists are riding the wave of interest and glory set off by Senator Mitch McConnell, whose avowed single most important thing to achieve is for President Obama to be a one-term president.  Not growth, not jobs – just defeat the president.  OK, that’s politics, it’s in that odd intersection between repugnant and fine – that’s how he rolls, he said it, I get it, I hope he doesn’t get what he wants, in fact, go fu--, well, at least we all know where we are.

My concern is that this attack on the Fed, born and coordinated over a sea bass dinner at the University of Pennsylvania Club (isn’t that an endangered species?), is really a new front in the political siege of the Obama Administration, and that the real problem with the Fed’s policy is that it might work.  Let’s return to Doug Holtz-Eakin, this time from this weekend’s Washington Post.

After the failure of the stimulus, the Obama Administration has turned to a new export strategy to generate growth. Unfortunately, export-led growth is already the policy of choice for China, Japan, Germany, Brazil and a host of other key economies. It is inconsistent for every country to simultaneously count on net exports to generate growth.

What Doug means by “a new export strategy” is that the QE2 monetary policy is likely to reduce the dollar’s value, which helps exports.  But that’s not the point of the policy.  If the Administration wanted to devalue the dollar, there are far more effective, direct ways of doing it.  And wait – this is the Fed’s policy, not Obama’s – why the sleight of hand, the bait and switch that lumps them together? 

Besides, if anybody has a right to a cheaper currency it’s us, since we have a big trade deficit.  The countries Doug cites all run trade surpluses – they should be happy when their currencies appreciate it, because now their people can buy more foreign stuff for the same amount of money.  If McCain were President, Doug, wouldn’t he favor China’s currency rising?  This criticism of QE2 is exactly what the Germans and Chinese said when they learned about it – that they didn’t want the US to export more.  Man, I get so tired of these right-wing economists who sign on to the arguments made by our competitors and blame America first.

Holtz-Eakin goes on:

The Fed (and President Obama, who curiously decided to violate the "Fed is independent" rule and weigh in on the topic) sees this as domestic monetary policy, but to the world it is a competitive devaluation of the dollar.

Well, there we go again – “the world” thinks such and such.  The world also thinks that the death penalty is barbarous, that climate change is scary as hell, and we all should get six weeks paid vacation, not to mention cradle-to-grave, government sponsored health care.  Are we good with that, too?  And what’s with this new rule about how Presidents shouldn’t comment on what the Fed does?  When did that start?   And that’s before we consider then-Fed Chairman Alan Greenspan dancing like a trained bear for tax cuts a decade ago.  Somebody send these guys the memo about the rule again.

He continues:

The Administration's approach has been to set quantitative targets for external balances - essentially "quotas" for shares of the global economic pie. It would never work and has been rejected.

I salute with grim admiration Doug’s ability to slip the word “quotas” into the mix, but what Tim Geithner really said was that if countries are running trade surpluses at really high levels, they should be under some obligation to cut them, meaning stimulating domestic demand and easing any trade barriers, pro-growth stuff.  And if it was rejected, it was rejected by the same list of trade surplus countries – China, Germany, Brazil – who actually do have the “export first” mentality Doug accuses Obama of having.

All of this suggests to me that the dissenting conservative economists –particularly given their overtly political so-signers -- are being guided by the McConnell Agenda, not a pro-growth one.  Cutting taxes for the rich, repealing health-care reform, and supporting any and all spending cuts except those that might happen (with the exception of Representative Paul Ryan, the new chairman of the House Budget Committee, who is perhaps the only Member of either party willing to enumerate what spending he’d cut) are not the makings of a program to restore output and employment growth – they’re modern day Hooverism.

And people who are good and thoughtful economists who signed this dissent – Holtz-Eakin, John Taylor, Niall Ferguson – need to think about what lies down this road – an populist attack on the Fed led by Sarah Palin and Ron Paul, folks who seem to lack the first idea of what the Fed does and why there’s more to monetary policy than a parable about gold coins.  If the Fed intends to do something that might help the economy while this Administration is in power, then off with its elitist head. 

Yes, the Wall Street Journal dissent is putatively above-board, but the board is surfing a very troublesome wave.  It’s a stalking horse – to some – for an attack on the Fed, for reasons ranging from ignorance to an anti-elitist Cultural Revolution.  The more responsible Fed critics should proceed with caution.